After a long legal fight, the FTC is sending BurnLounge victims $1.9M this week.

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Multi-level marketing is decades old, and BurnLounge was one of the first companies to bring it into the Internet age. From 2005 to 2007, BurnLounge executives and speakers told anyone who would listen that opening a digital music store, effectively a franchise of BurnLounge, could be the path to riches.

The BurnLounge music store did produce great wealth—for its founders, who were the top of an illegal pyramid scheme. The money didn't come from music sales, but from tens of thousands of wannabe digital entrepreneurs who bought into the plan. Of those recruited, 93.84 percent didn't even recover their initial investment, much less gain the six-figure incomes that BurnLounge execs promised were within easy reach.

The company was mostly shut down shortly after the FTC filed suit in 2007, when BurnLounge was slapped with a court injunction. But it kept fighting in court, losing after an eight-day bench trial was held in 2008. It wasn't until 2011 that US District Judge George Wu issued his judgment (PDF) that BurnLounge and its officers—Juan Alexander Arnold, John Taylor, Rob DeBoer, and Scott Elliot—had operated a pyramid scheme and deceived consumers.

BurnLounge appealed and lost again. Earlier this month, the US Court of Appeals for the 9th Circuit sided with the FTC. Yesterday, the FTC announced it's mailing 52,099 checks totaling nearly $1.9 million (~£1.2 million) to consumers who paid to become BurnLounge "moguls."

BurnLounge's website, meanwhile, has been frozen in time for eight years, still suggesting we should all "Get Ready" for BurnLounge 3.0.

“Some of you in this room are worth millions”

Customers of BurnLounge were given their own online store on a pre-made webpage, which the court called BurnPages. They paid for one of three packages: the Basic ($29.95 per year), Exclusive ($129.95 per year plus $8 per month), or VIP ($429.95 per year plus $8 per month). Selling music led to rewards points, which could be traded for cash if the consumer paid to join the Mogul program, an additional $6.95 per month.

The company guaranteed a minimum commission of just 50 cents for selling a $9.90 album, while offering bonuses of $10 to $50 for selling product packages—in other words, for recruiting. The FTC's expert found that 90 percent of the bonuses paid, minimum, would be for packages tied to recruitment, not for music.

The BurnLounge compensation system operated in successive "rings" in which each BurnLounge Mogul gets paid based on how many packages he or she sells, as well as bonuses based on the performance of the "downline." It was a "labyrinth of obfuscation," the judge found, and it was designed in a way that mathematically guaranteed it would be impossible for most Moguls to earn money. That didn't stop recruitment, however, which took place at live events and on teleconference calls.

"If you build a community that sells a few movies and sells a few games and sells a few downloads, you will have a license to print money," company CEO Juan Arnold told a New York audience in 2006, according to the FTC's complaint (PDF). "J.T. made $50,000 two weeks ago. He’s going to make probably $700,000 this year, and he’s a good old boy from Texas that can’t read."

"JT" was John Taylor, a Houston resident who had the top position in BurnLounge's complex compensation structure. He was the "number one Mogul" and sometimes referred to himself as "Retailer 001." On a 2006 conference call, Taylor said:

We have people all across the country that are generating, you know, part-time income, a few hundred dollars a month, to people that are earning, you know, a few hundred dollars a week, Scott, and then we’ve got people that are earning a few hundred dollars a day all the way up to 2, 3, $4000 a day.

Taylor made plenty of money, but as a judge would later note, it was nowhere near what was claimed at recruiting conferences. In Los Angeles, another speaker was willing to suggest that seven-figure incomes were available to those who believed:

Some of you in this room are worth millions... There's some of you in here that are looking for 1,000 a month, looking for 1,000 a week, and there's some of you looking for 1,000 a day. Just depends on what you want out of this business.

"Todd Ellis’ next door neighbor has made $280,000," Rob DeBoer told a Lawrenceville, Georgia, audience the same year. "We’ve got a dozen people that have made over $100,000."

BurnLounge had net revenues of $2.16 million in 2005, $19.16 million in 2006, and $6.83 million in the first six months of 2007 before it shut down.

Selling music, selling "opportunity"

Given the evidence showing that 94 percent of BurnLounge participants lost money, why would the company mount such a stiff defense? Not all multi-level marketing is illegal under US law; in fact, the landmark 1979 case In re Amway made some types of MLM industry explicitly legal. That case drew a distinction between legal multi-level marketing schemes and illegal pyramid schemes. That distinction continues to draw fire from critics, who say it's a distinction without a difference.

Pro-MLM rulings like In re Amway gave hope to BurnLounge lawyers. But the company got pounded at its 2007 trial, with the judge calling out BurnLounge recruiting statements like the ones above as "unambiguously false." Further, none of the promotional materials made it clear that Moguls were very unlikely to make any money. "Defendants Arnold, Taylor and DeBoer... never said the incomes were not typical, never said they were not representative of what the majority of Moguls would earn, and never disclosed that the majority of Moguls would not earn a profit," Wu explained in his ruling.

BurnLounge tried to argue the perks that came with its packages—like a subscription to its in-house BurnLounge Magazine, and "BurnLounge Presents," a subscription to get 10 music downloads and a music DVD every month—made the option a good deal as products. The company hired an expert who valued the magazine at $5 per issue and the Presents package at "at least $230 per year."

Providing music and DVDs that customers haven't even indicated they want, however, "is hardly worth the $340 per year that [expert] Nolte invents," Wu found. The valuation of $340 per year for the Exclusive package lacked evidence and was "grossly excessive."

For most buyers, the products in the high-end packages were just incidental to the real sale of a "business opportunity."

Of course, anyone setting up a BurnLounge online store and actually trying to sell music from it was competing against established enterprises like iTunes and Amazon, not to mention pirate sites where music was being downloaded for free. It was a tough market to break into with a pre-made webpage that didn't have any top 40 hits.

BurnLounge recruited 62,250 people into its program, with 60,270 of them choosing to become Moguls. Of those Moguls, 4.2 percent bought the Basic package, while 28.8 percent went for Exclusive and 67 percent bought the VIP Package. The company made $28.3 million in revenue (about £18 million), with sales of actual music accounting for just over $500,000 of that. The company paid out $17.4 million (~£11 million) in commissions, with 66 percent of that money going to the top one percent of Moguls, and 85 percent going to the top six percent.